Target Date Funds (TDF) have been among the most successful financial products ever created. They were designed to simplify long-term investing, and automatically become more conservative as fund approaches the retirement date. A significant amount of this success can be attributed Pension Protection Act of 2006, which enabled the U.S. Department of Labor to issue regulations that allowed TDFs to serve as qualified defaults within 401(k) defined contribution plans. As a result, TDFs have become the default investment option in over 60% of defined contribution plans with automatic enrollment.
Most investment vehicles are created based on specific capital market assumptions, economic dynamics and investment performance of risk reward trade-offs for given investment time-horizon. In addition to these considerations, reference date dependent investment vehicles' investment strategies are created based on assumptions about representative investor behavior and end goals. These assumptions include a beginning investor profile, investor saving behavior over time and investor end goals. The result of such assumptions is that the benchmark portfolio allocations exposure between TDFs vary significantly between families. These differences between TDFs have to be taken into account to present accurate retirement forecasts for investors, and to provide personalized guidance and advice.
Despite the success of TDFs, their short falls are gaining more recognition as such products go through their first stress test in a recessionary economic environment. For example, TDFs offer a “one size fits all” investment management solution that leave unanswered basic investor questions about how the TDF product will help investors achieve their retirement goals.
A particular Target Date investment vehicle may put significant retirement income at risk for an investor near retirement that is beyond that investors' risk tolerance. Such risks needs to be communicated to and highlighted for the investor. For example, in the year 2008 the 2010 TDFs from various families had equity percentage allocations ranging from 6% to 68%. This highlights the need for forward looking measures that can provide realistic retirement income estimates and risk estimates for the use of TDFs in retirement income planning for individuals.
Because investors generally lack knowledge of how an investment is related to achievement of goals, they cannot make appropriate saving contribution decisions. Accordingly, a vast majority of investors are underfunding their savings even though they may be automatically enrolled in their age appropriate TDF. Another current problem with the use of TDFs is that there is no current way to provide personalized guidance and/or advice to investors who have radically different profiles from the assumed idealized representative investor that was used to construct the Target Date investment. These problems have to be solved for TDFs to achieve their true potential within the financial industry. What is needed is a technology platform that provides financial services that can transform the product-oriented view of TDFs to a modern service-oriented, personalized financial services system which can also deliver automated managed accounts.
Traditional investor software provides asset allocation guidance and/or advice based on risk-reward trade-offs and investor risk preferences or goals. Some of these software packages provide asset class level guidance and/or advice, but leave the investor unsure of how to allocate to actual investable financial products.
More recently, a plethora of “retirement calculators” have become available to provide income forecasts at retirement based on static growth rates. More sophisticated versions allow Monte-Carlo simulations based on static investment strategies. These include “buy and hold” assumptions about the asset classes or periodically rebalanced to the original composition. Some of these calculators require the investor to input capital market assumptions such as future inflation and expected returns until investment horizons. These tools allow the investor to unrealistically manipulate economic variables to attain wishful retirement goals, and thus the resulting guidance and/or advice is misleading and dangerous. Careful calibration of the capital market assumptions by experts in the field is critical to providing an accurate long-term forecast for the investor. What is needed is a system that can either generate the capital market assumptions based on an accepted methodology and/or provide the capability for a registered investment advisor (RIA) or other asset manager to upload their existing capital market assumptions used across their business.
Most of the current the retirement calculators do not provide financial services for TDFs that accurately reflect the changing asset allocation over time. The tools that do exist apply simple static portfolio forecasting for TDFs, thus providing investors with inaccurate results on retirement goal achievability based on the current TDF asset allocation and/or current investor savings rates. These inaccurate results are compounded because they overstate the expected returns of a TDF investment strategy that will eventually become more conservative over time, and thus understate the required savings needed to achieve goals. Thus, these traditional calculators cannot provide accurate savings recommendations for investors in TDG or life-cycle investment vehicles.
A very specific retirement calculator that provides automated managed accounts solutions is described in U.S. Pat. No. 7,016,870 entitled Financial Advisory System. This system maps the available set of recommendable investments to the investor into an asset classes. It then performs a portfolio optimization to create an efficient risk/reward frontier for the investment horizon, and from this frontier picks the ideal asset class portfolio that maximizes the investor's utility function. The system then implements the investable portfolio that corresponds to this ideal asset class portfolio from the list of investible securities available to the investor.
Another very specific retirement calculator that provides automated managed accounts solutions is described in U.S. Patent Application Publication No. 2003/0172018 entitled Automatically Allocating and Rebalancing Discretionary Portfolios. This system determines the human capital of the individual as a bond, and dynamically allocates the financial capital of the person such that when combined with the human capital, the total wealth of the person achieves a desired optimal target ratio.
These prior-art retirement advice systems are designed to provide managed accounts solutions with discretionary investments that are used to create efficient portfolios, select an optimal portfolio for the individual, and offer automatic rebalancing of the discretionary investments. However, TDFs typically already consist of efficient portfolios with built-in investment advice and automatic rebalancing, and are designed for representative investors.
The mentioned prior-art advisory systems do no take into account the methodology assumptions used in creation of TDFs. First, mentioned prior-art advisory systems statically map financial investments to asset classes that limits the ability of these systems to respond to investment's that are expected to rebalance to a changing allocation to reference date. The systems then impose their own portfolio optimization with assumptions that ignore the already optimal portfolios represented by TDF investments. Due to these methodology incompatibilities, the existing advisory systems are inappropriate for providing personalized guidance and/or advice on how individual extenuating circumstances should or should not influence or compel an individual to deviate from the traditional age-based single factor assignment to a single TDF investment.